After this lecture you should be able to:

A. Examine the different elements of balance sheet B. Prepare balance sheet C. Interpret the information contained within a balance sheet.

Reading
Atrill & Mclaney (2008) Financial Accounting for Decision Makers, Chapter 2.

Learning Objective A
Examine the different elements of balance sheet

1. What is Balance Sheet?

Snapshot of the financial position At a particular moment in time.

Balance Sheet Equation

Capital + Liabilities = Assets. (1)
Capital + long-term liabilities + current liabilities = Fixed assets + Current assets .. (2) Fixed assets + [current assets current liabilities] long-term liabilities = Capital .. (3)

Balance Sheet as at 30th June 2008

Fixed assets (FA) Current assets (CA)
Less: current liabilities Net current assets Less: Long-term liabilities

X
X (X) X (X)

Net assets Capital (at the beginning of the year) Profits/(losses)

Capital (at the end of the year)

X X
X/(X) X
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Progress Check 1
Long-term bank loans raised 200,000. The effect of this transaction on the Balance Sheet equation will be:
a. b. c. d. Increase in capital and asset Decrease in asset and liability Increase in asset and liability Decrease in liability, capital and asset

2. What are the different elements of balance sheet?

Capital + Liabilities = Assets
Three elements in it:

Assets Liabilities and

Capital/equity/ownership interests.

Assets
Assets are the
valuable resources which provide future benefits acquired at a measurable cost and owned and controlled by the organisation.

Assets may be classified as:

fixed assets and current assets.

Fixed assets
Fixed assets are:
Long-term in nature Useful for more than one year. Examples include, land, building, plant and equipment. These are tangible fixed assets.

Another type of fixed assets: Intangibles.

have no physical substance. For example, goodwill, trademark, copyright etc.

Accounting Treatment:
B/S: at acquisition cost (including installation and other costs) less accumulated depreciation. P& L: annual depreciation is shown as an expense.
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Depreciation
All assets depreciate due to:
wear and tear,
obsolescence, reduction in value etc.

and have a finite useful life. Depreciation is a process of allocating the cost of an asset over its useful life.
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Depreciation Accounting
Example, Building cost 100,000; Useful life 50 years. Annual depreciation 100,000/50=2,000.

Profit and Loss Statement

Depreciation expense 2,000

Balance Sheet
Building Less: Accumulated Depreciation Book value or written down value 100,000 2,000 98,000 =======
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Current Assets
Convertible to cash within one a year or so.
Examples: stock, debtors, cash etc.

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Liabilities
Obligations to the outsiders.

It may be classified as:

current liabilities and long-term liabilities.

Current liabilities are payable within a year or so.

Examples: Trade creditors and bank overdraft.

Long-term liabilities are payable over a long period of time.

For example, 5 years loan taken from a bank.

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Provision
An amount provided for particular future expenses or losses.
Provisions for depreciation (accumulated depreciation) Provisions for bad debts

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Capital
It refers to the resources provided by the owners to the business.
Why do we show it on the capital and liability side of the Balance Sheet?

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Progress Check 2
Which of the following is an asset item? a. Goodwill

b. Stunning Chief Executive

c. Bank Overdraft

d. Outstanding wages.
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Learning Objective B

Preparation of Balance Sheet

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EXAMPLE 1: VERTICAL FORMAT

Prepare a balance sheet from the following information of Skylight Limited at 30th September, 2003:

Capital Profit and Loss Goodwill Land and Buildings Plant Motor vehicles Stock Bank Debtors Creditors Loans

1,200,000 285,000 150,000 500,000 375,000 50,000 225,000 510,000 415,000 410,000 330,000
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Skylight Limited Balance Sheet as at 30th September, 2003.

Fixed assets Goodwill Land and Buildings Plant Motor vehicles

150,000 500,000 375,000 50,000 _____ 1,075,000

Current assets Stock Debtors Bank

225,000 415,000 510,000 _____ 1,150,000 410,000 _____

Less: Current liabilities Creditors

740,000

Less: Long-term liabilities Loan

(330,000) _____ 1,485,,000 ==== 1,200,000 285,000 -------------1,485,000 =========

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Ownership interest Capital Profit and Loss

EXAMPLE 2: CHANGES IN BALANCE SHEET Sarah started a new business on 1 June. During the first month of her business the following transactions took place:

a Sarah opened a bank account in the name of her business and transferred 50,000 of her own money to it. b She borrowed 35,000 from the Commercial Loan Company and paid the money into the business bank account. c She paid 40,000 for a small business unit (premises). d She paid 3,000 for a second-hand delivery van. e She bought goods for resale for 10,000, paying immediately, and further goods for 20,000, on credit.
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f She sold goods, which had cost 15,000, for 25,000. 5,000 of this was cash sales and the remaining 20,000 was credit sales. g She paid staff wages for June totalling 500. h She paid 100 for petrol for the van. i She received 4,000 from trade debtors. j She paid 200 to the Commercial Loan Company as interest on the loan for the month.
Required:
Open a balance sheet for Sarahs business and show each of these transactions on it as a series of pluses and minuses to reach the position of the business as at the end of June. Ignore depreciation of the fixed assets. (Atrill & McLaney)

Journal Entry
a. Bank Capital Bank Loan Business Unit Bank Delivery Van Bank Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. 50,000 50,000 35,000 35,000 40,000 40,000 3,000 3,000

b.

c.

d.

Continuation of Journal Entries 2

e. (a) Inventory Bank (b) Inventory Accounts Payable f. (a) Bank Accounts Receivable Sales (b) Cost of the Goods Sold Inventory Dr. Cr. Dr. Cr. Dr. Dr. Cr. Dr. Cr. 10,000 10,000 20,000 20,000 5,000 20,000 25,000 15,000 15,000

Continuation of Journal Entries 3

g. Wage Bank Petrol Bank Bank Accounts Receivable Interest Bank Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. 500 500 100 100 4,000 4,000 200 200

h.

i.

j.

Bank Account
Debit Capital Account Loan Account Sales Account Accounts Receivable Account Pound 50,000 35,000 5,000 4,000 Credit Business unit Account Delivery Van Account Inventory Account Wage Account Petrol Account Interest Account Balance C/D Balance B/D 94,000 Balance B/D Pound 40,000 3,000 10,000 500 100 200 40,200 94,000

Delivery Van Account

Debit Bank Account Balance B/D

Pound 3,000 3,000 3,000

Credit Balance C/D

Pound 3,000 3,000

Petrol Account

Debit Bank Account

Pound 100

Credit Balance C/D

Pound 100

100 Balance B/D 100

100

Interest Account

Debit Bank Account Balance B/D

Pound 200 200 200

Credit Balance C/D

Pound 200 200

Loan Account

Debit Bank Account Balance B/D

Pound 35,000 35,000 35,000

Credit Balance C/D

Pound 35,000 35,000

Capital Account

Debit Balance C/D

Pound 50,000 50,000

Credit Bank Account Balance B/D 50,000 50,000 50,000

Pound

Business Unit Account

Debit Bank Account Balance B/D Pound 40,000 40,000 40,000 Credit Balance C/D Pound 40,000 40,000

Inventory Account
Debit Bank Account Accounts payable Account Balance B/D Pound 10,000 20,000 30,000 15,000 Credit Cost of the Goods sold account Balance C/D Pound 15,000 15,000 30,000

Sales Account
Debit Balance C/D Pound 25,000 Credit Bank Account Accounts Receivable Account 5,000 20,000 Pound

25,000
Balance B/D

25,000
25,000

Accounts Receivable Account

Debit Sales Account 20,000 20,000 Balance B/D 16,000 Pound Credit Bank Account Balance C/D 4,000 16,000 20,000 Pound

Account Payable Account

Debit Balance C/D Pound 20,000 20,000 Balance B/D Credit Inventory Account 20,000 20,000 20,000 Pound

Cost of Goods sold account

Debit Inventory Account Balance B/D Pound 15,000 15,000 15,000 Credit Balance C/D 15,000 15,000 Pound

Trial Balance
Debit Bank Account Inventory Account Pound 40,200 15,000 Credit Capital Account Accounts Payable Account Pound 50,000 20,000

Petrol Account
Delivery Van Account Interest Account Accounts Receivable Account Business Unit Account Cost of The Goods sold Account

100
3,000 200 16,000 40,000 15,000

Loan Account
Sales Account

35,000
25,000

Wage Account

500 1,30,000 1,30,000

Profit & Loss Account

Sales COGS Gross profit 25,000 -15,000 10,000

Operating Expenses: Petrol -100 Wages -500 Operating Profit 9,400 Interest Net Profit -200 9,200

Balance Sheet
Assets Non-Current Assets: Delivery Van Business Unit Current Assets: Closing stock (inventory) Accounts Receivable Bank 15,000.00 16,000.00 40,200.00 3,000.00 40,000.00 Current Liabilities: Accounts Payable Non-current Liabilities: Loan 35,000.00 20,000.00 Pound Capital & Liabilities Capital 50,000.00 59,200.00 (+)Net Profit 9,200.00 Pound

1,14,200.00

1,14,200.00

Sarahs Balance Sheet a

Assets Cash at bank 50,000

Capital and Liabilities Owners capital

50,000

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Sarahs Balance Sheet b

Assets Cash at bank [50,000+35,000] Capital and Liabilities Owners capital Loan 85,000

50,000 35,000 85,000

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Balance sheet as at the end of June

Assets Bank account Claims Capital (+50,000a 15,000f +5,000f 59,200 +20,000f 500g 100h 200j) (+50,000a +35,000b 40,000c 3,000d 10,000e +5,000f 500g 100h +4,000i 200j) Business unit (+40,000c) 40,000 40,200 Long-term creditor Commercial Loan Company (+35,000b) Motor van (+3,000d) Stock-in-trade (+10,000e +20,000e 15,000f) 15,000 Trade debtors (+20,000f 4,000i) 16,000 114,200 114,200
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35,000

Trade creditors 3,000 (+20,000e) 20,000

Learning Objective C

Interpretation of Balance Sheet Information

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B/S Interpretations
B/S limitations:
The value of assets may not reflect current value. Subjective valuation rules

May exclude important assets.

However, B/S provides useful insights to the financial health of a business:

Liquidity: ability to pay short term liabilities.
Asset Mix: appropriate mix of fixed and current assets. Financial Structure: appropriate mix of owned and borrowed capitals.

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Current Ratio
Indicator of short-term liquidity Current Asset/Current Liability

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Skylight Limited
Current Ratio (CA/CL) 1,150,000/410,000 = 2.8

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Home Task
Activity
Try to assess the financial health of Skylight Limited on the basis of balance information provided.

Home Task
Review self-assessment question 2.1, P.47 of your text book.

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